[Federal Register Volume 77, Number 104 (Wednesday, May 30, 2012)]
[Proposed Rules]
[Pages 31783-31786]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-12855]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-141075-09]
RIN 1545-BJ15
Property Transferred in Connection With the Performance of
Services Under Section 83
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations relating to
property transferred in connection with the performance of services
under section 83 of the Internal Revenue Code (Code). These proposed
regulations affect certain taxpayers who received property transferred
in connection with the performance of services.
DATES: Written or electronic comments must be received by August 28,
2012.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-141075-09), room
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
141075-09), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC, or sent electronically via the Federal
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-141075-09).
FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations,
Thomas Scholz or Dara Alderman at (202) 622-6030 (not a toll-free
number); concerning submissions of comments, and/or to request a
hearing, Oluwafunmilayo (Fumni) Taylor, at (202) 622-7180 (not toll-
free numbers).
SUPPLEMENTARY INFORMATION:
Background
Section 83(a) of the Internal Revenue Code (Code) provides that if,
in connection with the performance of services, property is transferred
to any person other than the person for whom such services are
performed, the excess of (1) the fair market value of the property
(determined without regard to lapse restrictions) at the first time the
rights of the person having the beneficial interest in such property
are transferable or are not subject to a substantial risk of
forfeiture, whichever occurs earlier, over (2) the amount (if any) paid
for such property, is included in the gross income of the service
provider in the first taxable year in which the rights of the person
having the beneficial interest in such property are transferable or are
not subject to a substantial risk of forfeiture. Section 83(c)(1)
provides that the rights of a person in property are subject to a
substantial risk of forfeiture if such person's rights to full
enjoyment of such property are conditioned upon the future performance
of substantial services by any individual.
Section 1.83-3(c)(1) provides that, for purposes of section 83 and
the regulations, whether a risk of forfeiture is substantial or not
depends upon the facts and circumstances. Section 1.83-3(c)(1) further
provides that a substantial risk of forfeiture exists where rights in
property that are transferred are conditioned, directly or indirectly,
upon the future performance (or refraining from performance) of
substantial services by any person, or the occurrence of a condition
related to a purpose of the transfer, and the possibility of forfeiture
is substantial if such condition is not satisfied. Illustrations
provided in Sec. 1.83-3(c)(2) of the regulations demonstrate when a
substantial risk of forfeiture will be considered to exist.
In addition to providing that a person's rights in property are
subject to a substantial risk of forfeiture if conditioned upon the
future
[[Page 31784]]
performance of substantial services by any individual, the legislative
history indicates that the drafters intended that ``in other cases the
question of whether there is a substantial risk of forfeiture depends
upon the facts and circumstances.'' H.R. Rep. No. 91-413 (Pt. 1), 91st
Cong., 1st Sess. 62, 88 (1969-3 Cum. Bull. 200, 255); S. Rep. No. 91-
552, 91st Cong., 1st Sess. 119, 121 (1969-3 Cum. Bull. 423, 501). The
current regulations adopt this approach by finding that a substantial
risk of forfeiture may also arise if the rights to the property are
subject to a condition related to the purpose of the transfer. Some
confusion has arisen as to whether other conditions may also give rise
to a substantial risk of forfeiture. See Robinson v. Commissioner, 805
F.2d 38 (1st Cir. 1986). The proposed regulations clarify that a
substantial risk of forfeiture may be established only through a
service condition or a condition related to the purpose of the
transfer.
Similarly, confusion has arisen as to whether, in determining
whether a substantial risk of forfeiture exists, the likelihood that a
condition related to the purpose of the transfer will occur must be
considered. Id. A conclusion that such likelihood need not be
considered would lead to anomalies not intended by the statute. For
example, assume that stock transferred by an employer to an employee
was made nontransferable and also subject to a condition that the stock
be forfeited if the gross receipts of the employer fell by 90% over the
next three years. Assume further that the employer is a longstanding
seller of a product and that there is no indication that either there
will be a fall in demand for the product or an inability of the
employer to sell the product, so that it is extremely unlikely that the
forfeiture condition will occur. Although, arguably, the condition is a
condition related to the purpose of the transfer because it would, to
some degree, incentivize the employee to prevent such a fall in gross
receipts, the Treasury Department and the IRS do not believe that such
a condition was intended to defer the taxation of the stock transfer.
Accordingly, the proposed regulations would clarify that, in
determining whether a substantial risk of forfeiture exists based on a
condition related to the purpose of the transfer, both the likelihood
that the forfeiture event will occur and the likelihood that the
forfeiture will be enforced must be considered.
Finally, the proposed regulations would clarify that, except as
specifically provided in section 83(c)(3) and Sec. 1.83-3(j) and (k),
transfer restrictions do not create a substantial risk of forfeiture,
including transfer restrictions which carry the potential for
forfeiture or disgorgement of some or all of the property, or other
penalties, if the restriction is violated. This position is supported
by the legislative history of section 83. The Senate Report, under the
heading ``General reasons for change,'' provides as follows:
The present tax treatment of restricted stock plans is
significantly more generous than the treatment specifically provided
in the law for other types of similarly funded deferred compensation
arrangements. An example of this disparity can be seen by comparing
the situation where stock is placed in a nonexempt employees' trust
rather than given directly to the employee subject to restrictions.
If an employer transfers stock to a trust for an employee and the
trust provides that the employee will receive the stock at the end
of 5 years if he is alive at that time, the employee is treated as
receiving and is taxed on the value of the stock at the time of the
transfer. However, if the employer, instead of contributing the
stock to the trust, gives the stock directly to the employee subject
to the restriction that it cannot be sold for 5 years, then the
employee's tax is deferred until the end of the 5-year period. In
the latter situation, the employee actually possesses the stock, can
vote it, and receives the dividends, yet his tax is deferred. In the
case of the trust, he may have none of these benefits, yet he is
taxed at the time the stock is transferred to the trust.
S. Rep. No. 91-552, 1969-3 CB 423, 500. See also H. Rep. No. 91-
413, 1969-3 CB 200, 254.
The legislative history shows that Congress intended for section 83
to be interpreted in such a way that precluded the use of transfer
restrictions as a means of deferring the taxable event. If interpreted
otherwise, section 83 would not alter the tax treatment of the
particular transaction that Congress described as the reason for the
statutory change.
Moreover, Congress later added section 83(c)(3) concerning sales
that may give rise to suit under section 16(b) of the Securities
Exchange Act of 1934 (the ``Exchange Act''). See Public Law 97-34, sec.
252, 1981-2 CB 256, 303. Section 83(c)(3) provides that so long as the
sale of property at a profit could subject a person to suit under
section 16(b) of the Exchange Act, such person's rights in such
property are (A) subject to a substantial risk of forfeiture, and (B)
not transferable. Section 1.83-3(j) of the regulations further provides
that, for purposes of section 83 and the regulations, if the sale of
property at a profit within six months after the purchase of the
property could subject a person to suit under section 16(b) of the
Exchange Act, the person's rights in the property are treated as
subject to a substantial risk of forfeiture and as not transferable
until the earlier of (i) the expiration of such six-month period, or
(ii) the first day on which the sale of such property at a profit will
not subject the person to suit under section 16(b) of the Exchange Act.
Consistent with section 83(c)(3) and Sec. 1.83-3(j), Revenue
Ruling 2005-48 (2005-2 CB 259) provides that the only provision of the
securities law that would delay taxation under section 83 is section
16(b) of the Exchange Act. The ruling further provides that other
transfer restrictions (such as restrictions imposed by lock-up
agreements or restrictions relating to insider trading under Rule 10b-5
of the Exchange Act) do not cause rights in property taxable under
section 83 to be substantially nonvested. Revenue Ruling 2005-48 notes
that the Treasury Department and the IRS intend to amend the section 83
regulations to explicitly set forth the holdings in the ruling.
Explanation of Provisions
The proposed regulations would amend the second sentence of Sec.
1.83-3(c)(1) of the existing regulations to add the word ``only'' to
the phrase ``[a] substantial risk of forfeiture exists [only] where * *
*'' The purpose of this addition is to clarify that a substantial risk
of forfeiture may be established only through a service condition or a
condition related to the purpose of the transfer.
The proposed regulations would amend the second sentence of Sec.
1.83-3(c)(1) of the existing regulations to delete the clause ``if such
condition is not satisfied.'' The purpose of the deletion is to clarify
that, in determining whether a substantial risk of forfeiture exists
based on a condition related to the purpose of the transfer, both the
likelihood that the forfeiture event will occur and the likelihood that
the forfeiture will be enforced must be considered.
The proposed regulations would amend Sec. 1.83-3(c)(1) of the
existing regulations to add a sentence stating that a transfer
restriction, including a transfer restriction which carries the
potential for forfeiture or disgorgement of some or all of the property
or other penalties if the restriction is violated, does not create a
substantial risk of forfeiture. The purpose of this addition is to
incorporate the holding in Rev. Rul. 2005-48.
Furthermore, consistent with Rev. Rul. 2005-48, the proposed
regulations would amend Sec. 1.83-3(j)(2) to include an example
illustrating the application of section 16(b) of the Exchange Act to
[[Page 31785]]
an option. The regulations are not intended to provide guidance on the
application of section 16(b) of the Exchange Act. Rather, for purposes
of the examples it is assumed that the period of liability is
determined in accordance with the applicable law, including any
applicable court decisions. See, for example, Stella v. Graham-Paige
Motors, 132 Fed. Supp. 100, 103 (S.D.N.Y. 1955), rev'd other grounds,
232 F.2d 299 (2d Cir.), cert. denied, 352 U.S. 831 (1956). The proposed
regulations also would add two additional examples to Sec. 1.83-
3(c)(4) illustrating that a substantial risk of forfeiture is not
created solely as a result of potential liability under Rule 10b-5 of
the Exchange Act or a lock-up agreement. Rev. Rul. 2005-48 will be
obsoleted when the proposed regulations are published as final
regulations. See Sec. 601.601(d)(2).
Proposed Effective Date
These regulations under section 83 are proposed to apply as of
January 1, 2013, and will apply to property transferred on or after
that date. Taxpayers may rely on the proposed regulations for property
transferred after publication of these proposed regulations in the
Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and because
the regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, these regulations have
been submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.
Comments and Requests for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are timely submitted to the
IRS. The IRS and the Treasury Department request comments on the
clarity of the proposed rules and how they can be made easier to
understand. All comments will be available for public inspection and
copying. A public hearing will be scheduled if requested in writing by
any person that timely submits written or electronic comments. If a
public hearing is scheduled, notice of the date, time, and place for
the hearing will be published in the Federal Register.
Drafting Information
The principal authors of these proposed regulations are Thomas
Scholz and Dara Alderman, Office of the Division Counsel/Associate
Chief Counsel (Tax Exempt and Government Entities). However, other
personnel from the IRS and the Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for Part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805.
Par. 2. Section 1.83-3 is amended by:
1. Revising paragraph (c)(1).
2. Adding Example 6 and Example 7 to paragraph (c)(4).
3. Adding Example 4 to paragraph (j)(2).
4. Removing paragraph (j)(3).
5. Redesignating paragraph (k)(1) as paragraph (k).
6. Removing paragraph (k)(2).
7. Adding paragraph (l).
The additions and revisions read as follows:
Sec. 1.83-3 Meaning and use of certain terms.
* * * * *
(c) Substantial risk of forfeiture--(1) In general. For purposes of
section 83 and the regulations, whether a risk of forfeiture is
substantial or not depends upon the facts and circumstances. A
substantial risk of forfeiture exists only where rights in property
that are transferred are conditioned, directly or indirectly, upon the
future performance (or refraining from performance) of substantial
services by any person, or upon the occurrence of a condition related
to a purpose of the transfer if the possibility of forfeiture is
substantial. Property is not transferred subject to a substantial risk
of forfeiture to the extent that the employer is required to pay the
fair market value of a portion of such property to the employee upon
the return of such property. The risk that the value of property will
decline during a certain period of time does not constitute a
substantial risk of forfeiture. A nonlapse restriction, standing by
itself, will not result in a substantial risk of forfeiture. Except as
set forth in paragraphs (j) and (k) of this section, restrictions on
the transfer of property, whether contractual or by operation of
applicable law, will not result in a substantial risk of forfeiture.
For this purpose, transfer restrictions that will not result in a
substantial risk of forfeiture include, but are not limited to,
restrictions that if violated, whether by transfer or attempted
transfer of the property, would result in the forfeiture of some or all
of the property, or liability by the employee for any damages,
penalties, fees or other amount.
* * * * *
(4) * * *
Example 6. On January 3, 2013, Y corporation grants to Q, an
officer of Y, a nonstatutory option to purchase Y common stock.
Although the option is immediately exercisable, it has no readily
ascertainable fair market value when it is granted. Under the
option, Q has the right to purchase 100 shares of Y common stock for
$10 per share, which is the fair market value of a Y share on the
date of grant of the option. On May 1, 2013, Y sells its common
stock in an initial public offering. Pursuant to an underwriting
agreement entered into in connection with the initial public
offering, Q agrees not to sell, otherwise dispose of, or hedge any Y
common stock from May 1 through November 1 of 2013 (``the lock-up
period''). Q exercises the option and Y shares are transferred to Q
on August 15, 2013, during the lock-up period. The underwriting
agreement does not impose a substantial risk of forfeiture on the Y
shares acquired by Q because the provisions of the agreement do not
condition Q's rights in the shares upon anyone's future performance
(or refraining from performance) of substantial services or on the
occurrence of a condition related to the purpose of the transfer of
shares to Q. Accordingly, neither section 83(c)(3) nor the
imposition of the lock-up period by the underwriting agreement
preclude taxation under section 83 when the shares resulting from
exercise of the option are transferred to Q.
Example 7. Assume the same facts as in Example 6, except that on
May 1, 2013, Y also adopts an insider trading compliance program,
under which, as applied to 2013, insiders (such as Q) may trade Y
shares only between November 5 and November 30 of that year (``the
trading window''). Under the program, if Q trades Y shares outside
the trading window without Y's permission, Y has the right to
terminate Q's employment. However, the exercise of the nonstatutory
options outside the trading window for the Y shares is not
prohibited under the insider trading compliance program. As of
August 15, 2013 (the date Q fully exercises the option), Q is in
possession of material nonpublic information concerning Y that would
subject him to liability under Rule
[[Page 31786]]
10b-5 under the Securities Exchange Act of 1934 if Q sold the Y
shares while in possession of such information. Neither the insider
trading compliance program nor the potential liability under Rule
10b-5 impose a substantial risk of forfeiture on the Y shares
acquired by Q, because the provisions of the program and Rule 10b-5
do not condition Q's rights in the shares upon anyone's future
performance (or refraining from performance) of substantial services
or on the occurrence of a condition related to the purpose of the
transfer of shares to Q. Accordingly, none of section 83(c)(3), the
imposition of the trading window by the insider trading compliance
program and the potential liability under Rule 10b-5 preclude
taxation under section 83 when the shares resulting from exercise of
the option are transferred to Q.
* * * * *
(j) * * *
(2) * * *
Example 4. On January 3, 2013, Y corporation grants to Q, an
officer of Y, a nonstatutory option to purchase Y common stock. Y
stock is traded on an established securities market. Although the
option is immediately exercisable, it has no readily ascertainable
fair market value when it is granted. Under the option, Q has the
right to purchase 100 shares of Y common stock for $10 per share,
which is the fair market value of a Y share on the date of grant of
the option. The grant of the option is not a transaction exempt from
section 16(b) of the Securities Exchange Act of 1934. On August 15,
2013, Y stock is trading at more than $10 per share. On that date, Q
fully exercises the option, paying the exercise price in cash, and
receives 100 Y shares. Q's rights in the shares received as a result
of the exercise are not conditioned upon the future performance of
substantial services. Because no exemption from section 16(b) was
available for the January 3, 2013 grant of the option, the section
16(b) liability period expires on July 1, 2013. Accordingly, the
section 16(b) liability period expires before the date that Q
exercises the option and the Y common stock is transferred to Q.
Thus, the shares acquired by Q pursuant to the exercise of the
option are not subject to a substantial risk of forfeiture under
section 83(c)(3) as a result of section 16(b). As a result, section
83(c)(3) does not preclude taxation under section 83 when the shares
acquired pursuant to the August 15, 2013 exercise of the option are
transferred to Q. If, instead, Q exercises the nonstatutory option
on May 30, 2013 when Y stock is trading at more than $10 per share,
the shares acquired are subject to a substantial risk of forfeiture
under section 83(c)(3) as a result of section 16(b) through July 1,
2013.
* * * * *
(l) Effective/applicability date. Paragraphs (j) and (k) of this
section apply to property transferred after December 31, 1981.
Paragraph (c)(1), Example 6 and 7 of paragraph (c)(4), and Example 4 of
paragraph (j)(2) of this section apply to property transferred on or
after January 1, 2013.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-12855 Filed 5-29-12; 8:45 am]
BILLING CODE 4830-01-P